Between 2009 and Q3 18 the US total debt has declined from a peak representing 350% of GDP in Q1 09 to 311.5% in Q3 18. While the US as a whole has been deleveraging, the business sector (corporate and non-corporate) has re-leveraged, standing at 72.6% of GDP or USD 15tn today. This represents a 2pp deviation to trend. Past recessions in the US have coincided with positive deviations ranging from 2-8pp of GDP.

According to our calculations, the true level of non-financial corporate debt in the US may be 30% or USD 3.9tn higher than officially reported, primarily because of leveraged loans bought by non-banks. We estimate that the debt-to-EBITDA ratio would thus be close to 4.6 instead of 3.9. As a consequence, the BAA-Treasuries’ spread (to AAA) should be about 120bps higher than currently observed (~ 230bps today) if hidden debt were factored in.

The Trump Administration’s fiscal stimulus has boosted demand in the US over the past couple of years. According to our model, a correction of this excess demand, back to potential output growth, could trigger an increase of the corporate delinquency rate from 1% in Q3 18 to 2.32% (highest level since Q2 11). This adjustment could follow strong disagreement about fiscal policy as we enter 2019-20 budget discussions. Corporate spreads will thus continue to hover around 230-250bps as seen today, still underestimating hidden debt, but aware of looming risks in the corporate sector. In a stress scenario (likelihood to switch estimated at 35%), which could correspond to a series of defaults for instance, the delinquency rate would jump to 3% and credit spreads would very quickly increase by 70bps higher than today.

The bottom line is that be it from scoping (hidden debt) or for cyclical reasons, we believe that corporate spreads are undervalued today, and that unfortunate events (rapid downturn, market defaults) could end up pushing up spread by 70-190bps, by sheer realization by market actors of intrinsic risks in that segment.